The July 2004 Senior Loan Officer Opinion Survey on Bank Lending Practices
addressed changes in the supply of, and demand for, bank loans to businesses
and households over the past three months. The survey also queried
banks about the extent to which recent bond market developments have
affected business lending. A set of special questions focused on
respondents holdings and recent extensions of adjustable-rate mortgages.
Responses were received from fifty-six domestic and nineteen foreign banking
institutions.

Both domestic banks and U.S. branches and agencies of foreign banks
further eased lending standards and terms for commercial and industrial
(C&I) loans, on net, over the past three months. A small net
fraction of domestic institutions also eased lending standards for commercial
real estate loans, while standards for this type of loan at foreign institutions
were essentially unchanged. A substantial net proportion of domestic
banks reported stronger demand for both C&I and commercial real estate
loans. Foreign respondents indicated a sharp turnaround in C&I
loan demand over the past three months; in contrast, demand for commercial
real estate loans at these institutions was reportedly unchanged over the
same period. In the household sector, a small net fraction of domestic
banks eased credit standards on residential mortgage loans, and the demand
for this type of loan was said to be slightly weaker, on net. The
demand for consumer loans of all types reportedly deteriorated as well
over the past three months, while lending standards and terms for these
loans were about unchanged.

Lending to Businesses(Table 1, questions 1-9; Table 2, questions 1-9)

In the July survey, both domestic and foreign institutions reported
a further net easingof credit standards on C&I loans. On net,
one-fifth of domestic banks indicated that they had eased standards for
large and middle-market business borrowers over the past three months,
a slightly lower net fraction than in the April survey. In contrast,
only 4percent of domestic institutions, on net, eased their lending standards
for small firms, a notable decline from the 20 percent figure in April.
The net percentage of U.S. branches and agencies of foreign banks that
stated they had eased their lending standards for C&I loans rose from
30 percent in April to 42 percent in the current survey.

Domestic and foreign respondents also indicated that they had eased
a number of lending terms on business loans over the past three months.
On net, about 30 percent of domestic commercial banks reported that they
had lowered spreads of loan rates over their cost of funds for large and
middle-market firms as well as for small firms. Among foreign institutions,
more than one-half of respondents, on net, reported having trimmed spreads
on C&I loans over the past three months. In addition, sizable
net fractions of both domestic and foreign institutions noted that they
had eased covenants on C&I loans, especially for loans to large and
middle-market firms. As in the April survey, both domestic and foreign
respondents indicated that they had eased terms on business credit lines,
both by increasing the size of credit lines and by reducing their cost.

More than 90 percent of domestic and almost 70 percent of foreign respondents
that eased their lending standards and terms over the previous three months
cited moreaggressive competition from other banks or nonbank lenders as
the most important reason for the change. In addition, 72 percent
of domestic and 77 percent of foreign institutions pointed to a more favorable
economic outlook as a reason for easing their business lending policies.
Domestic institutions also frequently pointed to improvements in industry-specific
problems and an increased tolerance for risk as reasons for their move
toward a less stringent lending posture. The small number of domestic
banks that had tightened their business lending standards or terms over
the past three months generally cited a reduced tolerance for risk or a
worsening of industry-specific problems as the reason for the change.

C&I loan demand.

Consistent with the recent turnaround in banks C&I lending,more
than one-third of domestic banks, on net, reported an increase in demand
for business loans from large and middle-market borrowers over the past
three months, a moderately higher net percentage than in the April survey;
about 40 percent of banks, on net, also reported stronger loan demand from
small firms. In addition, 45 percent of domestic respondents reported
an increase in inquiries from potential business borrowers over the same
period, about the same fraction as in the April survey. Domestic
respondents that experienced stronger loan demand over the past three months
pointed to their borrowers increased financing needs for accounts
receivable and inventories as well as for investment in plant and equipment.
Demand for business loans was also reported to have picked up at branches
and agencies of foreign banks, which had reported a weakening in demand
in the April survey. More than one-fourth of these institutions experienced
stronger demand in July; most of them attributed the pickup to an increase
in customer needs for M&A financing.

In light of the sharp decline in net bond issuance by nonfinancial corporations
in recent months, a special question on business financing asked banks
about the extent to which developments in the bond market had affected
their C&I lending. Although only 11 percent of domestic banks
reported a moderate decline in loan paydowns as a resultof the reduced
pace of bond issuance, more than one-fifth of foreign respondents noted
that lower bond issuance had caused a moderate or a substantial reduction
in C&I loan paydowns.

Commercial real estate lending.

On net, 9 percent of domestic banks reported thatthey had eased lending
standards on commercial real estate loans over the past three months, a
slightly lower net fraction than in the April survey. Lending standards
for this type of loan at U.S. branches and agencies of foreign banks were
essentially unchanged. The net percentage of domestic banks that
experienced an increase in demand for commercial real estate loans moved
up from 20 percent in April to 25 percent in the current survey.
In contrast, demand for such loans at foreign institutions was reportedly
unchanged, on net, over the past three months.

Lending to Households(Table 1, questions 10-20)

The net proportion of domestic commercial banks indicating an increased
willingnessto make consumer installment loans declined to 9 percent in
the July survey from 17 percent in the April survey. Standards for
approving applications for credit card and other consumer loans, as well
as most terms on these loans, were said to be unchanged, on net, in the
current survey. On net, 12 percent of banks reported weakerconsumer
loan demand in July, compared with 22 percent of institutions, on net,
that reported stronger demand in April. This reported slackening
in demand is not surprising given the slowdown in consumer loan growth
at banks during the spring.

In the current survey, 6 percent of domestic banks, on net, indicated
that they had eased credit standards on residential mortgage loans, about
the same as in April. On net, 8 percent of respondents experienced
weaker demand for residential real estate loans over the past three months,
a slightly higher net fraction than in the April survey.

The July survey included a set of special questions focusing on the
share of adjustable-rate mortgages (ARMs) on banks books, as well
as on the composition of ARMs originated during the past three months.1

About 45 percent of the domestic respondents indicated that conventional
ARMs adjustable-rate mortgages that reprice at regular intervals
accounted for less than 10 percent of all home mortgage loans on
their books; indeed, most of these institutions reported that such loans
accounted for less than 5 percent of their residential mortgage loans.
Only 12 percent of respondents noted that the share of conventional ARMs
was greater than 50 percent. In contrast, 30 percent of domestic
banks estimated that hybrid ARMs adjustable-rate
mortgages for which the interest rate is initially fixed for a multi-year
period but subsequently adjusts more frequently accounted for
more than one-half of all residential mortgage loans on their books.

In the case of conventional ARMs, the respondents indicated that on
average almost 90 percent of these loans will be repriced within the next
twelve months. In contrast, banks estimated that on average only
12 percent of hybrid ARMs will be repriced within one year; almost 60 percent
of hybrid ARMs on average, will not be repriced for at least three years.

More than one-half of the banks reported that hybrid ARMs accounted
for at least 75 percent of all ARMs originated during the past three months,
and another 17 percent of respondents indicated that such loans accounted
for between 30 percent and 75 percent of all originations over that period.

1. The number of banks that responded to these special
questions varied from thirty-six to fiftydepending on the question.
According to the first-quarter Call reports, the respondent banks accountedfor
as little as 35 percent and for as much as 57 percent of all residential
real estate loans on the books of domestic commercial banks as of January
31, 2004.

This document was prepared by Fabio Natalucci and Egon
Zakrajsek with the research assistance of Jason T. Grimm, Division of Monetary
Affairs, Board of Governors of the Federal Reserve System.